In early October, the PROMESA Financial Oversight and Management Board (FOMB) published a letter to Congressional leaders following the devastation in Puerto Rico (PR) due to Hurricanes Irma and Maria. FOMB stated that the hurricanes “have fundamentally changed Puerto Rico’s reality” and are expected to cause “lower revenues, higher costs, and delayed or reduced cost-saving measures that had been required by the FOMB’s fiscal plans.” It is widely expected that FOMB will revise the March 13 Certified Budget to reflect the hurricanes’ effect on the Commonwealth’s fiscal outlook. In this report, we make adjustments to the certified budget and estimate the potential increase in insured bond losses. We conclude that a 23% reduction in expected budgetary improvements would effectively erase PR’s ability to service any debt. We estimate that a reduction in the certified budget could reduce PR’s debt service capacity (DSC) by 20-60%, which would increase
losses for creditors and bond insurers. We maintain our view that Assured Guaranty, Ltd. (AGO), MBIA Inc. (MBI), and Ambac Financial Group (AMBC) will incur significant losses under Title III of PROMESA. AMBC and MBI face the highest risk given their exposure to COFINA bonds.
- Conclusion – All outcomes went from bad to worse. Puerto Rico’s March 13 Certified Budget (Figure 1) did not provide for sufficient funds to cover its debt obligations (Figure 2). Any revisions due to the hurricane damage are likely to further suppress cash flow available for debt service. We revisited the certified budget and estimated there will be no improvements in revenue or expenses in fiscal year (FY) 2018 and all projected improvements would be pushed out for 12 months. We also ran several sensitivity analyses on the budget and estimate a 14% reduction in projected improvements would eliminate the Commonwealth’s debt service capacity (DSC) prior to receiving any federal healthcare funds. After accounting for healthcare funds included in Congress’s Children’s Health Insurance Program (CHIP) budget bill (Section 106), PROMESA’s budget would have to decline by 23% to eliminate the island’s DSC.
- Meeting targets still results in lower cash flow.We ran two sensitivity analyses of PR’s certified budget. In both we assumed no improvements from revenue or expense measures in FY2018. The first scenario assumes the targets in the certified budget are hit, but FY2018 improvements are pushed into FY2019, FY2019 improvements into FY2020, etc. We estimate the reduction in cash flow available for debt service could only support $18 billion of debt (Figure 3), including federal healthcare funding, well below the $72 billion of debt currently outstanding. We also estimated that only 90% of the targets are hit again starting in FY2019 (i.e. 90% of FY2018 improvements are achieved in FY2019). This scenario can only support about $9 billion of debt. These estimates compare to DSC of $23 billion under the certified budget and represent a decline in DSC of 21-61% (Figure 4). We note that if the certified budget is revised down by 23%, it will eliminate the debt service capacity of the Commonwealth.
- Growth bonds are a likely solution.
There are some expectations that a revised PROMESA budget will eliminate all cash flows available for debt service. This outcome is plausible based on our sensitivity analysis at 90% of projections. With little to no cash flow available to service the Commonwealth’s $72 billion of debt, FOMB may offer growth bonds to most, if not all, creditors. FOMB has not announced when it expects certify a revised budget, but it is scheduled to meet today. The agenda covers several notable items including a discussion of a revised Commonwealth Fiscal Plan process and timetable, a report on the PR government’s financial and liquidity status, an independent debt investigation, and the contract review and approval process.
- Courts may make the final determination. If creditors, FOMB, and the Commonwealth cannot reach a settlement, the courts will determine which series of bonds will be paid and how much creditors will receive. With input from FOMB and the potential for a revised budget that shows severely depleted cash flow expectations, we can envision the court eliminating the vast majority of PR’s outstanding debt.
- COFINA poses a risk for AMBC and MBI. Until the matter is resolved by the courts, it is difficult to determine the amount of loss each monoline will incur and on what series of insured bonds. We view GO bonds as better positioned for court-ordered repayments given PR’s Constitution and the backing of the full faith and credit of the Commonwealth. We view the COFINA exposures of AMBC and MBI to pose the highest risk and this risk was elevated when bond payments were halted by the court. AMBC’s COFINA gross par and net debt service insured exposures totaled $809 million and $7.3 billion, respectively, as of June 30, 2017. MBI’s COFINA gross par and net debt service insured exposures were $684 million and $4.2 billion in 2Q17, respectively. By contrast, AGO had COFINA gross par exposure of $271 million and net debt service exposure of $619 million.
Upcoming events. Yesterday, the House Natural Resources Committee announced two hearings related to PR and disaster recovery efforts. On November 7, the committee will hold a hearing titled Examining Challenges in Puerto Rico’s Recovery and the Role of the Financial Oversight and Management Board. Then, on November 14, the committee will hold a hearing titled The Need for Transparent Financial Accountability in Territories’ Disaster Recovery Efforts, which is likely to focus on the PREPA and Whitefish Energy transaction, which was cancelled earlier this week.
AGO is scheduled to release its 3Q17 earnings after the market close on November 2 and will hold its call on November 3 at 8:00 a.m. On November 7, MBI is tentatively scheduled to release its 3Q17 earnings with a conference call on the morning of November 8. AMBC will release its 3Q17 earnings after the close on November 8 and will hold its conference call on the morning of November 9.
Monoline PR loss estimates. After FOMB certified PR’s budget, we moved our loss expectations to the adverse case. That outlook was confirmed when FOMB initiated Title III proceedings. After Hurricanes Irma and Maria, it is possible that our adverse case loss estimates will increase if, as expected, FOMB revises PR budget in manner that shows it will take longer for the Commonwealth to improve its fiscal condition and lowers its targeted improvements. We updated our loss scenarios and assume there will be no budgetary benefits in FY2018 and the benefits of restructure will affect the budget until FY2019. We project that revised budget will show the same revenue and expense improvements in FY2019 as was expected in FY2018 in the Certified Budget (100% achievement scenario). We also adjust the projected improvements down by 10% (90% achievement scenario). In the 100% achievement scenario, we raised our loss expectation for each debt issuance by 21%. We also estimate that if the revised budget is reduced by 23% from the Certified Budget, the Commonwealth will not have any cash flow available for debt service. In the 90% achievement scenario, we raised our loss expectation for each debt issuance by 61%. This resulted in a number of issuances becoming complete losses, including COFINA, Highway and Transportation Authority, convention center bonds, and PRIFA bonds (Figure 6).
Assured Guaranty, Ltd.: In the 100% achievement scenario, we estimate AGO’s after-tax present value (ATPV) losses to be 42.2 billion or $17.85 per share (Figure 11). These losses increase to $2.5 billion and $20.44 per share in the 90% achievement scenario (Figure 13). The loss per share is equal to 57% of AGO’s reported book value in 2Q17. These losses increased from our PR Certified Budget scenario losses $1.8 billion or $14.75 per share (Figure 9).
MBIA Inc.: We estimate MBI’s ATPV losses in the 100% achievement scenario to be $1.9 billion or $14.77 per share. This represents over 95% of MBI’s 2Q17 reported book value (Figure 18). In the 90% achievement scenario, our loss estimate is $2.2 billion or $17.58 per share, which is greater than MBI’s reported book value of $15.45 (Figure 20).
In the PR Certified Budget loss scenario for 2017 and beyond, we estimated MBI’s insured PR payments to be $1.5 billion or $12.23 per share (Figure 16).
S&P downgraded National Public Finance Guarantee Corporation (NPFG) and MBI made the decision to stop writing new business and run the company as if it were in liquidation at least for the intermediate term. The downgrade and change in business outlook likely eliminates any likelihood that MBI will receive approval from New York Department of Financial Services (NYDFS) for a special dividend from NPFG. If FOMB significantly reduces cash flow available for debt service, it would increase the risk that NYDFS would halt dividends from NPFG to MBIA, Inc. This could put MBI on a path towards bankruptcy. Our assessment is that the Title III resolution will take three or more years to resolve. We do not expect NYDFS to stop the dividend payments until NPFG’s PR loss content is identified and its effect on NPFG’s capital position is assessed.
Ambac Financial Group: For AMBC, ATPV losses are projected to be $1.2 billion or $26.07 per share in the 100% achievement scenario (Figure 25). These losses increase to $1.3 billion and $28.71 per share (78% of book value) in the 90% achievement scenario (Figure 27). For comparison, we estimated AMBC’s PR Certified Budget ATPV losses to be $986 million. The estimated loss per share was $21.55, which represents 58% of AMC’s reported BV (Figure 23).
A revised budget could impact MBI the most. We updated our monoline PR loss models using the achievement of 100% and 90% of targeted improvements in PR’s Certified Budget. We compared the updated estimated losses to MBI’s, AMBC’s and AGO’s claim paying resources as well as the present value of each company’s insured PR debt service payments. For MBI, its after-tax present value (ATPV) insured losses represent over 40% of its claims paying resources if the revised budget achieves 100% of the targeted revenue generation and expenses savings (Figure 17) and 48% if only 90% is achieved (Figure 19). This is up from our estimated 33% using the Certified Budget (Figure 15). MBI has $4.6 billion of claims paying resources as of June 30, 2017 and updated loss estimates are $1.8 billion in the 100% and $2.2 billion in the 90% scenario. Our estimated losses under the Certified Budget were $1.5 billion.
For AGO, we estimate the ATPV losses to be $2.2 billion in the 100% achievement scenario and represent 18% of its $12.2 billion of CPR (Figure 10). In the 90% achievement scenario, estimated ATPV losses are $2.5 billion and equal 21% of its claims paying resources (Figure 12). These estimates are up from 15% of claims paying resources under the Certified Budget (Figure 8).
AMBC’s claims paying resources excluding Ambac UK’s resources total just under $8.0 billion (Figure 22). Under the 100% achievement scenario, we estimate AMBC’s ATPV losses to be $1.2 billion and represent 15% of claims paying resources (Figure 24). AMBC’s ATPV losses are estimated to be $1.3 billion in the 90% achievement scenario and equal almost 17% of its claims paying resources. Our estimated losses under the Certified Budget were 12% of AMBC’s adjusted CPR (Figure 22).
GO creditors have the edge over COFINA. In our view, the full faith and credit of PR stands behind general obligation (GO) bonds. The taxing authority of the Legislative Assembly stands behind obligations issued with the full faith of the PR government. The restructuring will determine the debt issuances that benefit from the full faith of the PR government, which could favor GO bonds over COFINA and put the COFINA trusts at serious risk. According to the Government Development Bank, “the good faith, credit and taxing power of the Commonwealth have been pledged” to GO bonds. Article VI Section 8 of PR’s Constitution makes it clear that interest and debt amortization will be paid first. The real issue is how FOMB addresses GO and COFINA bondholder claims. All other debt issuances are at serious risk of significant, if not total, losses.
Our assessment of the counterproposal is that the full faith and credit stands behind GO bonds and not COFINA bonds. We reach this conclusion based on the following language in the counterproposal: “litigate with COFINA creditors to successful conclusion or settle within debt capacity.” It is unclear what debt capacity is defined as, but it would seem to be the available capacity after settling with GO bondholders.
The counterproposal also stated, “closing would be subject to an acceptable settlement with COFINA or successful completion of COFINA litigation.” We believe the repeated mention of litigation with regards to COFINA illustrates that the Commonwealth does not view COFINA bonds as having the full faith and credit of Commonwealth supporting them.
MBI has insured COFINA debt service payments totaling $4.2 billion and AMBC has exposure of $7.3 billion, which represents 49% and 76%, respectively, of each company’s total PR exposure (Figure 5). In addition, AMBC only has $65 million of GO insured exposure and $211 million of Public Building Authority (PBA) GO exposure, which represents 3% of its total PR exposure. MBI has GO exposure of $898 million and PBA exposure of $281 million or 14% of its total PR exposure. Conversely, GO and PBA exposures represent 32% of AGO’s PR exposure and COFINAs only represent 8%.